The Passive revolution
All over the world investment fees have fallen substantially, not just as a result of lost trust in investment bankers’ post 2008, but with the massive increase in the use of ‘passive’ funds that use cheap computers instead of expensive asset managers to structure long term portfolios. In other words they just follow what the stock market is doing and don’t try and get clever and ‘beat’ the market. The losers are the ‘mutual funds’ what we call Unit trusts or collective investments here in RSA. Gone are the days when asset managers could get away with fees of up to 3%. Passive investments usually come in below 0.5%, and some even lower than 0.3% and we haven’t seen the bottom yet. Why are we in SA dragging our heels to keep up with this global trend?
One answer could lie in our much higher inflation for the fees to hide behind. If you take 3% off a 10% growth you’re still getting 7%. Factor in inflation of 6% and the real growth is only one percent. It looks very different to taking 3% off a 5% growth ( which is in line with the kind of growth they have been experiencing in the West), their inflation is still around 1%, so the nett effect is the same – but the perception by clients is way different. Basically we have been hiding behind double digit growth. Investors are happy to share in times of good growth, but when things swing down they aren’t quite so magnanimous.
The trend to lower cost passive investing has already started in earnest and clients that are following offshore trends are (rightly) insisting on these lower fees, especially for long term investments like retirement funds.
Performance fees – which are essentially hidden – are another bone of contention and the government has woken up to the problem and started to demand ‘clean’ pricing (without the dirty performance fees) for retirement funding, starting with the Tax Free Savings accounts. Performance fees have a number of issues. Firstly they are imposed on future performance based on past performance. In other words, new money coming into the fund has to pay the fee despite not having enjoyed the return in excess of the benchmark. Secondly, some collective investments build their own benchmark – making it impossible for you to compare apples with apples. It’s like doing your own performance review.
“Fund of Funds” (FoF for short) are also going to come under pressure because of the layers of fees and performance fees. These are unit trusts made up of other unit trusts, so you not only have the costs of the underlying unit trust but another whole layer of fees to yet another asset manager piggy-backing on the work of other asset managers to get a ‘best of breed’ because he can’t do it himself.
We mustn’t ignore the fact that our growth in South Africa isn’t all about having a higher inflation, our stock-markets have been growing faster in real terms than those in the West, which is why a third or more of the investors on the JSE are offshore.
The chickens are going to come home to roost when the stock market slows down. At the moment it is savvy or penny pinching investors that have cottoned onto lower fees, but if we go the way the rest of the world is going (and there is no reason we won’t) then the active asset managers are going to be hurting. The industry is overdue a disruption, and that is coming.
One place a disrupt is really overdue is in the massive ‘retirement’ industry. ‘Member choice’ was the clarion call of the industry. It sounds like democracy – right? Member choice meant they could choose all those high flying, widely advertised funds they saw on TV every night. Somebody has to pay for all that marketing – guess who? In reality the sum total of most member’s understanding of the fund they are choosing begins and ends with the just the name – no more. This is in no way a criticism, investment and the economy is a complicated thing to keep ontop of and almost impossible if you don’t have a passion for it.
I guess a lot of the choice of known funds is about ‘trust’. The financial services industry hasn’t exactly covered itself in glory in the past, and there are still plenty of skeletons hiding in closets waiting to be uncovered. When the man on the street is constantly reading about dodgy investment schemes or property syndicates is it any wonder they look for a safe haven for their investments?
In personal and group investments alike fees are going to start to fall it is just a matter of who is going to be victim – is the asset manager or financial advisor? Who has the better value proposition? Who are you going to pay that 1% to? The asset manager for getting you 1% above the average after fees or the advisor who tells you which buckets to put your investments into depending on your objectives, tax requirements, liquidity needs and which asset classes to use? There will always be investors that have more confidence in their ability and knowledge than is warranted, or others that are just desperate to make up for lost time and will not see the value of advice under any circumstances. This is one of the reasons people, often retirees, are taken for a ride when it comes to investment – greed, unwarranted ‘wisdom’ and desperation.
Financial advisors have an opportunity to get ahead of the curve – identify and research well established low-cost funds, trackers and ETFs and start phasing them into your client’s portfolios – obviously backed by skills transfer and education. For higher net worth clients ‘personal share portfolios’ are another lower cost option (these can be ‘wrapped’ as RAs, Annuities, preservers – or any of those investments that require a ‘Life’ license.
Action: Investors need to open this conversation with their advisors. Be aware that your advisor may not have access to these sort of investments on their license (especially so-called tied agents for the large insurance companies). This is where fee-based advice comes into it’s own. The advisor gets remunerated for his/her advice and you get unbiased advice. If you’ve got a pension or provident fund don’t jump on the expensive, well known unit trusts, look at the cheaper alternatives with the same returns. Your advisor will be able to guide you on this switch.
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Author Dawn Ridler ©